Since the beginning of December, bond yields have been on a swift declineThe 10-year government bond yield has fallen below the critical 2.0% mark, and subsequently, it has dipped beneath 1.8%, representing a nearly 90 basis points decrease since the start of the yearThis sharp drop in yields has generated a mix of excitement and concern among bond investorsWhile the current year has seen substantial profits from bond products, there is underlying anxiety about the future profitability given the continuous decrease in interest rates.

Analyzing the logic behind the persistent decline in interest rates, it can be understood as a characteristic of the economy experiencing a contraction in volume, consequently leading to lower capital returnsThe reduction in capital returns inherently translates into falling interest ratesVarious factors contribute to this slowdown in debt leverage, both internal and external

On the internal front, soaring property leverage and skyrocketing housing prices have made the situation untenable, while external issues such as trade frictions play a role as wellHistorically, during phases of reduced leverage among households and enterprises in Japan, bond yields similarly descendedAlthough China's bond yields may not reach the historically low levels seen in Japan, it is critical to note that current Chinese yields are significantly above Japan's nadir.

In examining Japan's situation, it's evident that the trend of falling bond yields has only shown signs of recovery in the last three to four yearsThis uptick in yields has coincided with improvements in the economy, inflation, and a resurgence in debt leverageThe recent recovery in Japan's economy, inflation rates, and interest rates can be attributed to a combination of favorable internal and external factors, rather than merely local policy stimulation

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For instance, the global inflationary wave emanating from the pandemic has encouraged Japanese residents and businesses to acknowledge inflation's reality, adjusting their economic activities accordinglyFurthermore, Japan has regained strategic economic support from the United States, leading to a renewed influx of foreign investmentOn the domestic front, the Japanese government has taken steps to encourage inflation, implementing strategies aligned with this goalFor example, the Bank of Japan has maintained a relatively easy monetary policy despite rising inflation, and in recent years, it has actively motivated corporations to increase wages, thus bolstering consumer spending and investment confidence.

Turning to China's current scenario, there are also burgeoning internal factors that could facilitate economic recoverySince September, we have witnessed a gradual shift towards more proactive policy measures aimed at stabilizing growth

For economic revitalization, it is vital to expect further fiscal stimuli alongside increased fiscal deficitsShould the fiscal deficit rise, this could potentially lead to an increase in the issuance of national and local bonds, which may provide a boost to social financing increment in 2025. Predictions suggest a rebound in social financing increments for 2025 compared to 2024, although surpassing previous highs remains uncertainHistorically, a V-shaped recovery in the economy following policy-induced stimuli has generally corresponded with new highs in social financing increments, marking a new phase of economic milestone.

In a context of relatively restrained fiscal action, the importance of monetary policy easing cannot be overstatedThis has led to December’s policy meeting reframing the monetary policy tone from “prudent” back towards “moderately easing.” According to economic principles, the Fisher equation disaggregates economic growth into factors of money growth and the velocity of money supply

Fiscal policy mainly addresses the aspect of money growth, while monetary policy's role is to stimulate an increase in the velocity of money circulationEvaluating the monetary conditions index—which combines indicators of money supply growth, real interest rates, and real exchange rates—historically reflects that the loosened state prevailing post-2009 financial crisis was marked by a very high monetary conditions index, prompting drastic reductions in reserve requirements and interest ratesThe ongoing low position of the current monetary conditions index suggests a necessity for initial rate reductions in the monetary market to promote easing.

This low index suggests a decrease in money supply growth and high real interest rates; hence, to guide down the actual interest rates, focus should be directed towards lowering money market interest ratesHistorically, the downward adjustment of money market rates has been sluggish, creating a bottleneck that has compromised the ability of overall loan rates, non-standard rates, deposit rates, and long-term bond rates to correspondingly decrease in a swift manner, leading to a compression of interest margins within financial institutions

In 2023, the central bank has consistently pushed to lower deposit rates, aiming to discourage household savings while advocating increased consumer and investment spendingHowever, the lagging reduction in money market rates has kept interest rates on non-bank investment products higher than deposit rates, deterring consumers and businesses from channeling funds into consumption and investment, thereby favoring non-bank productsThis pattern not only fails to boost the velocity of money but also complicates revitalizing the real economy.

How low must the money market interest rates drop for a reduction in the diversion of deposits towards non-bank products? We propose that at a minimum, the one-year certificate of deposit rate must align with the one-year deposit rate to ease this diversion effectIf money market interest rates undergo a further significant decline, logically, the yield on the ten-year government bonds may still have room to decrease

This multi-year bull market in bonds can be interpreted through a sequence of complementary decreases across various rates within the interest rate framework: first came the significant fall in loan rates from 2021-2022, resulting in the initial decline of bond yields; then during the first eight months of 2023-2024, falling deposit rates and existing housing loan rates induced another drop in bond yields; finally, the round of adjustments in money market rates initiated in September 2024 would contribute to a further decline in bond yieldsShould this final round of adjustments fail to galvanize the economy effectively, it may provoke a fourth round of comprehensive rate reductions across the board, further pushing bond yields down.

While the downward trajectory of interest rates is crucial, currency exchange rates also remain a significant influencing factor, although not strictly a binding constraint

The United States, currently grappling with considerable fiscal pressure, would similarly need to steer interest rates lower to alleviate its debt burdenIn fact, China’s real interest rates are already higher than those of the United States, implying that lower nominal rates in China won't necessarily lead to depreciation pressures on the domestic currency.

Moreover, beyond standard measures such as required reserve ratio cuts and interest rate reductions to chart the course for falling bond and monetary rates, we also have grounds to expect an increase in central bank purchases of government bonds within a moderately easing monetary framework next yearThis increase would imply that the incrementally issued government and local bonds in 2025 would likely be absorbed by the central bank, establishing a narrative where the overall supply of bonds remains inadequate in relation to the easing monetary conditions, thus perpetuating the logic of asset scarcity